New Company Share Trading Rules

The share trading policies now required of all ASX listed companies seem to restrict trading freedom unnecessarily while confusing what will most benefit potential investors.

All the ASX listed companies have been required to publish share trading policies before 1 January along the lines required by recently revised listing rules. Now, there should be no doubt about when employees, directors or consultants can trade the shares of the companies with which they are engaged.

The requirement can be seen in one of two ways:

just another piece of paperwork required by largely impotent regulators unable to tackle insider trading effectively; or

an important reform to reassure investors they have sufficiently equal access to information that they will not be disadvantaged when taking a decision to buy or sell shares.

Both perceptions have some basis. There are already laws relating to insider trading under which fines and terms of imprisonment may apply to anyone found guilty of an infringement. At the same time, companies are required to adhere to a strict continuous disclosure regime which implies, at any point in time, that all information material to an investment has been made known to the broader market. To that degree, the additional requirements are redundant.

Unfortunately, despite threats of dire, life changing consequences, suspicious trading persists. Too often, one of the signs a WA mining company is about to make a stock market announcement is that the share price rises in the few days before!

The frequency of such occurrences stretches the credibility of markets. At the margin, potential investors may eschew participating, concluding that others simply have too much of an information edge.

An explicitly stated trading policy can go some way to eliminating the information imbalance insofar as it puts clear obstacles in the way of employees with access to information trading ahead of company news.

The trading policies released in December generally identify periods during which no trading can occur. They also, to varying degrees, require key management personnel to obtain explicit approval before buying or selling shares in the companies with which they are associated.

These policies imply symmetry between the effects of insider buying and selling; that either can have a detrimental effect of a similar magnitude. That is not clear.

At any time, simply by being listed, all companies are either implicitly or explicitly urging people to buy their shares. Under these circumstances, neither existing shareholders nor potential investors should feel aggrieved at employees of any seniority buying shares in the company at any time. Such purchasers would simply be acting in accordance with the actions they are urging on everyone else.

In contrast, if company executives sell shares at any time, they would be acting contrary to what they had been urging on everyone else. There could be many reasons for such sales including compelling personal financial circumstances but selling would always be inconsistent with what managers have been telling the market.

This suggests that the assumption of symmetric costs from buying or selling is misplaced and that a different set of rules, such as the two following, might be more appropriate.

Allow executives to buy stock at any time as long as they are not in possession of information inconsistent with what the company has told the market. Of course, in a continuous disclosure environment, the market should always be fully informed.

Require executives to seek approval for any stock sales - whenever they are to occur. Moreover, require the company to announce two days before any sales the total number of shares approved for sale by insiders.

If a mining company, for example, had flagged that it would release the results of a scoping study demonstrating the viability of a new mining operation on a particular day, an employee could freely purchase shares in the days preceding the release. If, on the other hand, the study was inconsistent with the project going ahead, a purchase would not be allowed. However, as soon as the company was aware of the change in circumstances, it would have an obligation to inform the market.

In another instance, if a company had foreshadowed an annual profit outcome of, say, $100-115 million, an employee could purchase shares prior to the release of the results unless he had information that the anticipated outcome was not likely to eventuate.

Such a set of rules would simplify and explicitly recognize the true costs and consequences of executive share transactions. They would minimize the number of constraints on share trading, improving market efficiency.

Executives would not be stopped from purchasing shares. Most importantly, if they decided to sell, there would be a clear signal to all potential investors that the people who had been urging them to buy had changed their minds. This would be valuable information for a potential investor approaching a decision to buy.

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